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MR. SAHADI: I think, to add to that, with a cost of 60 to 85 cents, those benefits in other institutions would have to be very significant.

MR. WHITE: It depends on the number of institutions in applies to benefit.

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Let me further ask you about the criticisms of the methodology, itself. A few commenters raised questions about just the bias in the cost numbers themselves, that a lot of these cost numbers are estimated cost to the FSLIC, and that if the estimators had a bias in valuing direct investment, that they might well be undervaluing direct investments, and that that would, in turn, cause, at least some, if not all, of the effects that you if you found any effects.

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MR. BISENIUS: As you're well aware, I'm sure, from your own research, any time one does empirical research, the data is not perfect.

The notion that the numbers are somehow biased, I don't believe there's any test run to detect that, as I'm not aware of exactly what type of test would be run to detect that.

The numbers that were used in the study, as the -- deep into variable FSLIC costs were -- if a cost number was available, an actual cost number, this was the outlay, that was the number that was used. If an actual cost outlay number was not available, then the number that were used were those that were estimated by the FSLIC staff. Again, the best numbers available at the time the study was done

MR. BLACK: And with your permission, I would also say that if one were to a priori guess at any direction of bias in those estimates, since it's in FSLIC's interest to have higher dollar values to the assets since it, after all, wants to sell them. That's how FSLIC recoups its money.

I don't think one would guess, if he had to make a guess, that there would be any systematic bias towards under-reporting of the values of assets in the FSLIC portfolio. And, indeed, our experience tends to be that when we ultimately do have to sell assets, they are very frequently under those estimates. The actual prices we get are very frequently under those estimates.

And apropos your earlier question about the degree of bias in terms of selection, if you simply look at the statistics and how many people, how many insured institutions, do view it in their interest to exceed 10 percent direct investments. Again, the numbers are very, very tiny.

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I think that ORPOS has some statistics on how few institutions believe themselves apparently that they will get significant positive benefits from exceeding 10 percent in direct investment.

MR. WHITE: I think you've just reminded me of yet another criticism that was levied at the study, which was that it really didn't address the specific provisions of the rule that you can't tell from the study whether it's really the high fliers, or somewhere else in the distribution, that are causing the effects on the price.

MR. BISENIUS: Right. The study does not differentiate direct investment levels; it doesn't, you know, stratify this in that fashion.

MR. WHITE: The last criticism that I remember is that there is a correlation between delay and the likelihood that a savings and loan institution would decide to "shoot the moon" on a direct investment; the returns are asymmetric and the management gets the up side returns, but we here at FSLIC have to pick up the pieces if it fails. And that correlation between delay and the tendency to go out on a limb with direct investment might be somehow explained here.

MR. BISENIUS: Again, I think that is definitely a possibility, in these. There was a significant coefficient on the delay variable. And I believe that's consistent with the statements of the Chairman in his opening remarks, and that is at a time when FSLIC is not able to act maybe as rapidly as it otherwise would like to, extra caution needs to be taken. I think that's something that variable indicates.

Whether or not that somehow is correlated or influencing the results in the direct investment coefficient, I'm not certain. I guess my one inclination is, and maybe you've already dealt with this, is that there's not a lot of reason to believe that that would only influence direct investment. Again, an institution which seeks to "plunge," while direct investment is one asset it could choose, there's obviously an entire array of assets that it could choose to plunge in. To the extent those other assets did not show up as significant, I'm not sure the conclusion can be drawn.

MR. WHITE: Now, I don't know, Bob, if I'm anticipating, but there is the question of the relationship between the study we've just been talking about and studies that have tried to determine whether direct investment levels bear any relationship to the likelihood that a thrift will fail in the first place.

Am I getting it? Am I getting it? I don't want to

MR. SAHADI: Well, I think -- we'll go through some of those studies, but I think, you know, basically we're justifying the reg on the significant cost to the FSLIC; that we're in the position of an insurance company that's identified that there are tremendously high costs to this in the event of failure, and these costs, when added up, well exceed the reserves of the FSLIC.

You know, we're not trying to make a case that the econometricians have conclusively determined that casualty has been determined but, on the other hand, we purport to show a lot of anecdotal information that is almost overwhelming in respect that this may be the case if further studies can be refined.

MR. WHITE: I just remembered one more sorry about that -- one more question. And that's this issue of misclassification that is claimed that thrifts may well be misclassifying, and particularly at the time that the study covered, were misclassifying direct investments and putting them into ADC categories rather than in the direct investment category that they really should have been.

MR. BISENIUS: That's been, you know, a question of concern. I think the Board has taken steps to deal with that misclassification problem. Whether or not that actually influenced the results of the cost study, again, it's difficult to discern. One can only plug into the model, the variables which you have available, the various items, direct investment or acquisition and development loans fall into different categories.

One interesting point, though, is that both of those variables were significant in influencing costs, both the direct investment and the acquisition and development loans.

To the extent there was some misclassifying, that may indicate why one or the other became significant.

MR. BLACK: To add to it, as Bob has said, the principal argument he's making from the econometrics standpoint is this one involving cost. The Board certainly has very substantial supervisory experience and in, for example, the question you asked, Board Member White, were these failures --"high fliers" --- you're certainly right. The study didn't look at it, and I'm sure that further work on the study will look at that issue. But the Board has in front of it its supervisory experience, and it knows that the Sunrises of the world, et cetera, were not simply "high fliers" but extraordinary "high fliers," that properly, their assets properly classified as direct investments, they were well in excess of 10 percent. I mean their portfolio was more in the 70 percent range.

MR. GRAY: Let me try to remember that case. As I recall

MR. WHITE: Before my time.

MR. GRAY: Just before your time.
[Laughter]

I believe we found that there were $780 million in, what were on, an economic basis, of direct investments. In fact, we're told that by the Chief Financial Officer of the institution.

The institution, as I recall, was roughly $1.5 billion, and that institution is estimated to cost - will cost the FSLIC about $680

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million at one institution, one-and-a-half billion dollars.

MR. BLACK: And Sunrise is simply one of the leading examples. The supervisory experience is these kinds of high fliers were pervasive in that. That cost study was of that group.

MR. HENKEL:

October '86?

Question. The study you're talking about is dated when?

MR. SAHADI: Which one are we talking about? The cost study?

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MR. BISENIUS: It used data through October 1985, the exam period was from 1981 through October '85. Just a second, Bill.

MR. BLACK:

MR. GRAY:

MR. HENKEL:

Okay.

Do you have any question on this? Go ahead.

What, what's it entitled? I'm confused about which study is which.

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"Failure Cost of Government Regulated Financial Firms in Case of Thrift Institutions."

MR. HENKEL: I've got one dated October of 1986. got the wrong one?

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MR. BISENIUS: No, it's not that may be when the actual cover was put on top of it.

THE CHAIRMAN: All right. If there are no further questions at this time, the staff can continue.

MR. SAHADI: Okay. Since our proposal, we've done two other studies that cast some further light on this situation.

The Chairman mentioned both of these in his opening remarks. walk you through them.

Let me

In October of 1986, the OPER staff conducted a study to follow up on the performance and current condition of institutions examined by Professor Benston in a 1984 study. In this study, he presented the results of a statistical study which he contended supported unlimited direct investment for insured institutions.

One aspect of his study was to identify the institution that as of December 1983 had direct investments in excess of 10 percent of assets.

Professor Benston contended that the study showed that these institutions had considerable net worth and were quite profitable.

In its October study, the OPER staff determined that there were 37 institutions with direct investments in excess of 10 percent as of December 1983. Professor Benston in his study had only found 34.

The average regulatory capital ratio of these 37 institutions, as a percent of liabilities, was 4.3 percent in December 1983.

By June 1986, that ratio had declined by 96 percent, from 4.3 percent to .23 percent.

By way of comparison, the thrift industry's average regulatory capital ratios were 4.2 percent in 1983, and close to 4.7 percent in June 1986.

MR. GRAY: Now, let me stop you there. You're saying that the average regulatory net worth of the 37 institutions in December of 1983 was 4.3 percent, and by June of 1986 it had dropped to virtually near insolvency on an average basis?

MR. SAHADI: Yes.

MR. GRAY: What was 0.23 percent.

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While at the same time, you're saying the thrift industry's average net worth, which was 4.18 percent in December '83, had risen -- actually risen by comparison -- it had risen; the others had gone down to 0.23 percent, but the average for the industry had risen to 4.66 percent on June 30th, 1986.

MR. SAHADI: Since 1983, 21 of these 37 institutions have either failed, become FSLIC cases, or are currently considered a significant supervisory case by the Office of Regulatory Policy and Oversight.

Ten of the 21 institutions are currently in the FSLIC caseload. They have assets of $6.3 billion, and the estimated cost to FSLIC to resolve them is $2 billion.

The current average return on assets for these 10 institutions is a negative thousand basis points.

Another eight of these 21 cases are in FSLIC's significant supervisory caseload. These institutions have assets of 3.75 billion and the FSLIC estimates the cost resolving them will be approximately 1.2 billion.

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